Arbitration nightmare

Despite win, investors might never be paid

McClatchy Tribune

Published 7:53 pm, Saturday, July 27, 2013

Sergio Alvarado, left, and his wife Tina, who is disabled with various health issues, sit in their home in Round Lake, Illinois, July 9, 2013. Sergio, an investor, was awarded more than $700,000 in damages in 2012 after a dispute with his brokerage went through arbitration. But almost a year later, Alvarado still hasn't been able to collect. (Jose M. Osorio/Chicago Tribune/MCT)

Investor Sergio Alvarado of Round Lake, Ill., was awarded $748,000 in damages and interest in October after a dispute with his brokerage went through arbitration.

Alvarado, however, still hasn't collected a dime.

He's in a class of investors who get burned by their brokers, fight back through arbitration and win — and then await payment. Awards are generally supposed to be paid within a month through a process run by the Financial Industry Regulatory Authority, a quasi-governmental overseer of brokerages.

But the percentage of awards going unpaid has more than doubled recently, FINRA's internal statistics show.

In 2011, aggrieved investors were unable to collect on $51 million of the $481 million that the authority awarded. Most brokerages require prospective clients to agree to go through FINRA's arbitration process if disputes arise.

That means that 11 percent of claims that FINRA deemed legitimate went unpaid. It had fallen to only 4 percent the two prior years, according to statistics that the authority provided the Chicago Tribune.

Many of the unpaid awards are owed by firms that go out of business, leaving a trail of wronged investors empty-handed, because "there is no requirement that broker-dealers carry insurance to cover potential losses in arbitration," the Public Investors Arbitration Bar Association wrote in a letter last year to the Securities and Exchange Commission, the government arm that oversees the investment industry.

Historically, 15 percent to 33 percent of awards granted through FINRA have gone unpaid by member firms, the trade group of lawyers who represent investors in disputes said in its letter to the SEC.

To be sure, the insolvency or failure of thinly capitalized brokerage firms due to arbitration awards has been a perennial problem, but claims against smaller firms have proliferated recently, the association said.

For example, almost three dozen brokers that in recent years sold private placements in oil-and-gas company Provident Royalties have gone out of business, according to trade publication Investment News. A key reason: They were unable to pay the cost of investor complaints in what turned out to be a Ponzi scheme.

"We have multiple arbitration awards where the clients will never get paid," said Chicago securities lawyer Andrew Stoltmann, who is representing Alvarado. "Investors need to be aware that unless you are dealing with a major national or regional brokerage firm, if something goes wrong and you sue, there is a real chance you won't get paid."

Because unpaid arbitration awards are common, Stoltmann said he turns down two cases a week in which he's confident that the investor has been defrauded but is pessimistic about the brokerage's ability to pay should it lose at FINRA arbitration.

FINRA itself is part of the problem, Stoltmann said.

"FINRA has the ability to mandate certain rules that would completely eliminate this problem: requiring mandatory meaningful insurance," he said. "It's unwilling to do that."

In 2012, 45 percent of cases taken to FINRA arbitration resulted in awards for investors, the authority says on its website. That 45 percent represented 255 cases.

An "Investor's Guide to Securities Industry Disputes" on FINRA's website puts investors on notice that if a broker or brokerage goes out of business or declares bankruptcy, then they might not be able to collect an arbitration award.

"Being able to collect once an award is rendered is perhaps the most important reason to carefully select your broker and brokerage firm by thoroughly checking their history and longevity in the securities industry," the FINRA guide says.